Monday, 16 December 2013

That sucking sound...

If growth is the measure then 2013 must have been the year of Xero. The firm's stock price really shot away over the last few months as its market capitalisation blasted past Telecom, becoming the forth biggest on the NZX. Here is the price chart from the ASX.

Xero is a great example of a platform business. It wants to attract several different types of patron, and as this happens Xero becomes more attractive to everyone else. The main groups seem to be:

  • final customers, mainly SMEs looking for an easier option for accounting;
  • investors in the very sexy SaaS sector; and
  • app developers looking for opportunities to sell add-ons to Xero customers.
Think about the connections between these groups: investors want more customers because that means more profits. They also want more app developers because that builds the 'ecosystem' and helps to add customers. App developers want more investors and more customers because that gives them confidence that the business will endure and they'll get a decent return on their investment.

As for customers, well these days when people want me to switch to Xero, they often mention its sharemarket success as evidence that it must be a good thing. I don't buy that story but suspect others do. Anyway, Xero has very wisely decided to contract out large chunks of the customer side of its business by recruiting accountants to sell the service to their clients. Which incidentally also tells us that this model is modifying but not supplanting accountants.

The most interesting point though, is that we are watching a massive network effect in operation here. It is stimulated by Xero marketing itself to several different groups at once, and by each group wanting more of the others around. As the buzz grows, more patrons of different types get sucked into the Xero ecosystem. Its a truly wonderful thing, even though it does confound the hell out of valuers.

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